Q: It looks like Britain is facing the bleakest economic outlook in ten years. Is this your biggest challenge as you deal with real public disquiet over economic issues?

A: This is one of the most difficult years for the world economy. There's absolutely no doubt, no doubt about it. We've seen a credit crunch. It obviously started in the United States of America. But the global nature of financial markets means that it spread right across Europe and has got an impact on all the major industrial economies as things stand. It is combined with the uncertainty about the international situation that has produced very high and rising oil prices and commodity prices.

And so you've got a credit crunch and you've also got potentially an inflation problem in some parts of the world and that is always a very dangerous time for the international economy. All the evidence in America is that maybe one and a half to two million residents who own homes may go into very substantial mortgage arrears or even be repossessed. So the costs of mortgages in the States are rising very fast. And therefore you've got this impact potentially on the American consumer economy directly through what has happened. So this is a difficult and dangerous situation for the world economy.

The question of course for Britain is how will we fare over these, over these next few months? I believe that we have got to be vigilant. We've got to act quickly where there are difficulties. We've got to work very closely on the side of business facing this difficult time. But I also believe that Britain is better placed than most to withstand the global turbulence. I believe in many ways that Britain is best placed because of the decisions that we have made both recently and in the past and I think that while it is a testing time and we have got to be vigilant, I am determined to use all my energies to make sure that Britain comes through this difficult period and we maintain the stability and growth which has been a feature of all of the last ten years when I've been part of the government.

And why am I saying that Britain is better placed because I believe we have an economic resilience that we perhaps did not have ten, fifteen or twenty years ago. And why is that the case? It's because we've got inflation low. Now these were very difficult decisions we made at the beginning of the last year on public sector pay and they were not popular decisions because they were long term decisions about the stability of the economy. And so to stage the public pay awards sent a signal and it's unfortunate because I would like to have given the police more, nurses more. I'd like to have given the prison officers and the teachers and others more.

But our decision to stage the public sector pay award means that inflation fell in Britain and we managed to bring interest rates in the last, the last few weeks. Without these big decisions about inflation I believe we would have been entering a most difficult period for the world economy without the same flexibility and resilience that we now have. So we enter this very difficult period with Britain better positioned because we've got low inflation, because we've got a record of stability, because employment is higher than ever it has been in our history.

In other words we are not seeing unemployment at this stage rising. And I believe that the financial decisions that we made to rescue Northern Rock, to improve the transparency of financial institutions, to work for better reform of the international institutions, a better early warning system are also important to that. So if you look at the next few months, a testing time. We've got to be vigilant.

But I believe for the reasons that I've given Britain has got an economic resilience that other economies have had in the past but we now have to enable us to withstand some of the more turbulent events that have been a feature of the global economy in recent times.

Q: But what would your message be to people who may not buy into such a rosy outlook - people facing rising energy bills, more expensive mortgages and higher levels of personal debt?

A: But I'm not in any way complacent. Let's start from ...

Q: No, but on the ground there are people who have real concerns about money issues.

A: Absolutely. If you look at what's happening in America then obviously where all the issues started - America - you've got mortgage arrears, you've got repossessions, you've got a slow down in the house building market, you've got rising mortgage payments and therefore you've got an effect and also likely on the consumer economy. And that is side by side with rising oil prices. But if you look at America today, America's got four per cent inflation. The Euro has got three per cent inflation. We've managed through the difficult decisions that we made to get down to two per cent. Now it's the strength to take the long term decisions that matters.

That is as true of the, if you like the stability of the economy as it is of all the big infrastructure decisions on nuclear, on planning, on housing, on transport and infrastructure, welfare to work. All these difficult decisions that we're taking, because when I talk about this being a decisive year, this is the year when we will make and implement all the major long term decisions that are going to safeguard and equip Britain properly for the future.

But if you take the domestic economy and the strength of the domestic economy, by being prepared to take difficult decisions about pay, about being prepared to take difficult decisions about the public spending round, we've put ourselves in a better position to withstand a global turbulence that is affecting every economy. And that's why I say that yes of course it is difficult but it would be more difficult if interest rates had had to rise last month instead of fall last month. Interest rates did not fall in the Euro area because inflation was above three per cent. Interest rates fell in Britain because we had got inflation down to around two per cent. And that's what I mean when I say that the worst situation for a government is what happened fifteen years ago, twenty years ago, twenty five years ago, when facing international turbulence, inflation is too high and you cannot cut interest rates, unemployment is rising and therefore the consumer economy is directly affected.

So I am not complacent at all. I am absolutely focused on this issue that Britain must steer its way through, steer this course of stability through a global turbulence. But I believe we are well positioned to do it because of difficult decisions that we've been prepared to make.

Q: But it's undeniable that Britons are going to feel a bit more pain.

A: What's clear is that if interest rates can, if the Bank of England can continue to have the flexibility to deal with interest rates in the way it thinks best and that is the independence of the bank in a situation where you have low inflation then they are in a position to avoid what sometimes happens and historically happened in Britain when you're facing an inflation problem and you have to raise interest rates.

Our aim must be that we have got inflation to a point where although there are difficulties ahead because utility prices are, for example rising as a result of what's happening to gas and oil prices round the world, the important thing is that you've got the economy in a position where inflation is sufficiently low to enable the Bank of England to have the flexibility on interest rates.

Now that is the difference between - look in 1990, 1991 and 1992 you had ten per cent inflation and you ended up with fifteen per cent interest rates. And the moment that the government ought to have been cutting interest rates it had to raise them because inflation was too high. We got ourselves into a position by the tough decisions we took on inflation. This was not popular what happened during the course of last year. I do understand it. The nurses deserve as do the police to have, if it were at all possible, the higher pay settlements that we wanted to give them.

But there was a general view that we had to stage public sector pay in order to get inflation down. And it's these tough, difficult, long term decisions that most of the opposition parties are not prepared to make that has characterised what I've tried to do in the economy over the last ten years. And having the strength to take the long term decisions like freezing public expenditure ten years ago, being very tough on public sector pay for many of the years that we've had to deal with public sector pay, staging public sector pay last year that are the key to being in a position to say that you are resilient, even in difficult circumstances, as long as you're also vigilant.

Q: During your ten years as Chancellor you made a case for managing the economy prudently. And at a macro level that certainly happened. But at a micro level something else was happening where Britain as a nation was developing a serious habit of credit binging with personal debt and record levels of insolvency. Now this happened while you were Chancellor. My question would be whether you think you did enough to restrict personal and institutional lending during that period given the hardships that it is now causing?

A: If you take the level of personal debt to income, the level of mortgage repayments that people have got to make in relation to their income, it's very substantially lower than it was in the early years of the 1990s. Now nobody wants to return to that awful period when interest rates were so high that people's mortgages were way beyond what they could afford.

And it's back to this issue. Yes, there will be people that take advantage of a liberalised economy and sometimes make the wrong personal decisions for their own debt. And we must have the best advice and the best help for people in these circumstances. If you take for example people's assets against their borrowings, people have seen real wealth in this country rise by more than sixty per cent since 1997, mainly of course because there had been rises in the value of assets including property prices.

So I would say yes where people get into difficulty we must do far more as we are trying to do with the services we provide, whether it's us supporting the consumers, Citizens Advice Bureaus or us supporting counselling to help people in that position. But generally I think people have their own understanding of what is the relationship between their assets and what they are borrowing.

Q: Does it frustrate you that that people miscalculate what they can afford to borrow? And how can you teach better financial management?

A: Well I agree with you about teaching better financial management. And we've given money to the Financial Services Authority so that there's more teaching in financial literacy. In fact I was just talking to someone the other day who's very much involved in these programmes to help people whether it's at school to learn ..

Q: Should it happen at school level?

A: Yes absolutely. And I would favour more education in financial management and in financial budgeting generally at school. And that would be a good thing. But I don't necessarily take your full conclusion. I mean if you take some of the instances of repossessions or liquidations in a dynamic economy as people move and there is a great deal of mobility, some people will get themselves into difficulty. We've got to help them.

But generally speaking the level of assets in the economy has risen quite fast. And you take pensions. I mean people have said rightly so that we've got to make sure that everybody has security in retirement. And if I say to you that the assets of our pension funds had doubled from 500 billion to a trillion over the last ten years people don't actually think that because they think there has been something else going on. Actually the assets of pension funds have doubled over the last ten years. So people have wealth in their houses, they have wealth in their pensions.

And that is not complacent because I would like to see lower income people having more wealth. I'd like to see the financial literacy that you want to see extended particularly through schools and colleges and their education programme. But I don't know if we should draw a general conclusion about the economy because savings ratios vary a great deal in different countries depending on what the economic circumstances of the time are.

Q: Given the ill winds that are blowing across the Atlantic have been caused by the credit crunch would you warn people to be careful about levels of credit? Would you be warning borrowers to be vigilant? Or is that not something for a prime minister to get involved in?

A: I think the more important thing is to say to people you know the contexts in which you make your decisions are ones which are difficult globally but we will do everything that we can to steer that course of stability. It is that grip on the stability of the economy that has been absolutely decisive in my view for Britain becoming the least volatile of all the industrial economies in the last ten years.

If someone had said to you ten years ago that the British economy would be more stable than most, would have lower inflation than many, that it would have maintained a record of recession free growth for ten years very few people - while America has had a recession, while Germany's had a recession, while the rest of, Japan has been almost in a long term recession - very few people would have believed that that was possible. And we not only have high growth - but this is the key to it - if you have high growth - and we are the fastest growing economy in the G7 at the moment. We not only have high growth but we've got high employment. We've got you know three million, almost three million more people in employment than in 1997. And we've cut unemployment by half as a result of that. If you look at what goes wrong in economies [it] is when you either have fast rising unemployment or fast rising inflation and the things that you want to do to curb that like lower interest rates become impossible to do. Now the bank was able to reduce interest rates because we'd kept inflation low. And as I say American inflation today is about four per cent and ours is about two per cent. And that has been the key I think to our ability to make some of the decisions over the last few weeks.

Q: You said in your New Year message that 2008 will be a year for long term decisions. What are they and when will they take place?

A: I think people take a long term view on these things. And I think what people will want to see is what happens to the economy -- to interest rates, inflation and growth in the economy, employment in the economy, over a long period of time. And they will also want to look at who's making the right long term decisions for the future of the country.

I do say that this year is decisive because this year we will have to make a decision yes or no on nuclear power. And we will publish our proposals next week. We will have to make a decision yes or no on planning and how we deal with making some of the big decisions about planning the future of, physical planning the future of the country. We've got a housing bill that we want to use to build three million houses over the next few years which is solving the, at least part of the problem about housing demand. We have got legislation coming through on CrossRail, on Heathrow, on big infrastructure decisions which if the country doesn't make now then we will either be congested or be unable to cope with some of the problems in the years to come.

We're making big decisions on science. I do say to you that London and Britain stands poised to be the European capital for medical research in future years because some of the decisions we're making at the moment and we're bringing Professor Paul Nurse, you know who won the Nobel Prize for cancer who left famously to go to the United States. He's coming back to Britain to lead this medical research project in London. So we're making big decisions about science.

Q: Whereabouts in London?

A: It's at St Pancras. It's a great project where we're bringing together Cancer Research UK, the Medical Research Council and the Welcome Trust. Fifteen hundred world class scientists, pioneering research. The pharmaceutical companies will join it. I've been working with other people to bring this about.

So Britain leading the way in creative industries, in financial services, in medical research and pharmaceuticals in a way that I think people will be very proud of Britain in future years. And I suppose the next stage is our education reform. So you've got the long term reforms on energy, climate change I should mention also because we're the first government, country in the world to legally cut, to, you know, to legislate to cut emissions by law over a period of time and to set up a climate change committee that's independent to advise us on that. And so all these big decisions - housing, energy, planning, infrastructure and pensions. The Pensions Bill is now about to go through the House of Commons as well. So all the big long term decisions.

Now what's really fascinating is that the Opposition parties are against almost all these big long term decisions. And I think it's opportunist. And I think it's not putting the long term interests of the country before the short term political gain to parties. But obviously some of these decisions are controversial. And obviously some of them are about long term commitments that you've got to make about investment and the way you use funds when you can have short term consumption in place of it.

But that's why I say this year is a decisive year. Because if we make these long term decisions on planning and nuclear, on energy generally, on climate change, on housing, on science and then at the same time build in a world class commitment to education then we have if you like made all the right long term decisions that are necessary for an industrial country like ours that is an advanced industrial country to compete with China, India and also with our European and American neighbours.

So I see this year as a decisive year in long term changes and long term reforms that are both radical and bold and at the same time breaking new ground that governments have not been prepared to break before. And if we can combine that with raising people's aspirations about what the skills level of our economy could be, about how children can do better in schools, how standards can rise in education, how more young people can get college and apprenticeship qualifications, how actually we could raise not just the standards but the aspirations of young people to unlock all the talent of the British people, then we are one of the best placed countries to do well in this new global economy.